With Rio Tinto's Snub of Chinalco, Aussie Backlash Against China's New Capitalists Continues to Escalate

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By Jason Simpkins
Managing Editor
Money Morning

Australia defied the global trend in the first quarter, recording a 0.4% year-over-year rise in gross domestic product (GDP).

Of course, Australia’s economy didn’t shrug off the global economic downturn all by itself. It got a very big helping hand from China, a country whose growing influence in the Pacific has been both a blessing and a curse for the land down under.

"Today's national accounts data shows a fairly large contribution to growth from net exports in the March quarter, and that follows a substantial contribution to growth from net exports in the December quarter," said Australian Treasury Secretary Ken Henry. "We've got two quarters now of strong contribution from net exports and, of course, the other strong contributor in this quarter is household consumption."

But over the past six months, the bulk of Australia’s exports have been headed to China—Australia’s largest trading partner—and haven’t been split between the Red Dragon, Japan and the United States, since those latter two developed economies have been mired in a deep downturn.

China is a growing nation with insatiable needs. It needs cotton and wool for its textile factories, iron ore for its steel mills, coal for its power plants, and grain for its growing population. And Australia, which is a mere 4,641 miles away, has an abundance of all these goods.

China consumes half of Australia’s wool and half of its iron ore exports, as well. In fact, China consumes nearly half of Australia’s total mineral exports.

Australia's share of exports to emerging countries rose to 53 %, compared with 43% 10 years ago, Harcourt said. And exports to China have seen an average annual growth of 24.8% in that time.

"According to research commissioned by the Australia China Business Council, the average Australian household now benefits to the tune of A$3,400 ($2,550) a year from Australia's trade with China," Harcourt said.

China’s foreign direct investment (FDI) in Australia also has soared. China’s total FDI in Australia reached $5 billion (A$6.2 billion) in 2007, a 78% year-over-year increase and a 120% increase over five years.

"Investment is also an increasingly important part of the Australia-China relationship,” said Harcourt. “Strong outward FDI flows from China are replacing the traditional trade route as a form of global engagement."

But while China’s voracious appetite for resources has been the flotation device that’s kept the Aussie economy from joining others on the ocean floor, there is a growing sense in Australia that China has become a little too enamored with Australia’s out-of-the-earth bounty.

Indeed, Australia’s cozy relationship has become something of a political bugaboo for Prime Minister Kevin Rudd. Before being elected prime minister, Rudd, who speaks fluent Mandarin, worked as diplomat in Beijing for Australia’s Department of Foreign Affairs. And now his political opposition has seized on his China ties to portray him as a puppet for Beijing’s politburo.

Malcolm Turnbull, leader of Australia’s Opposition party, accused Rudd of acting like a “spokesman” and a “roving ambassador” for China rather than looking after Australia’s national interests.

That argument may have seemed somewhat alarmist when it was first launched, but it’s gaining momentum. Australians fear that if China gains too much control over their country’s resources, Beijing will also gain powerful political leverage it can use to influence future Australian policies.

“It’s the Communist People’s Republic of China, 100% Communist-owned, buying up sections of the country and minerals in the ground which they will then sell to the Communist People’s Republic of China,” said Barnaby Joyce, who is a leader of the National Party in Parliament. “And we’re going to live off the commission on the way through. They’ll try to make sure we get as little as possible.”

China’s domestic reserves can meet demand for fewer than half of 45 strategic minerals, Paul Glasson, a Shanghai-based Australian who brokers deals between Chinese and Australian businesses, told TheNew York Times. By 2020, it will have sufficient supplies for just six.

“In a nation of 1.3 billion people, with the complex issues they face, with such resource deprivation, would it be wise for the government to abdicate that responsibility to [Chinese state owned enterprises]?” Glasson asked.

Business Meets Pressure

This was the question the Australians were forced to confront in February when Aluminum Corp. of China (NYSE ADR: ACH), known as Chinalco, struck a $19.5 billion financing deal struck with Rio Tinto PLC (NYSE ADR: RTP), the world’s third-largest miner.

Before the deal, Rio was saddled with about $40 billion in total debt, about half of which was incurred in its 2008 purchase of Alcan. The deal called on Chinalco to take a $12.5 billion stake in Rio’s mining assets and purchase $7.2 billion in convertible bonds. It also would have given Chinalco two seats on Rio Tinto’s board.

Australian politicians seized the opportunity to paint the deal as yet another case of Prime Minister Rudd inviting Chinese interests to walk off with Australian assets at bargain prices.

“The Australian government would never be allowed to buy a mine in China. So why would we allow the Chinese government to buy and control a key strategic asset in our country,” said the ads, which aired in the capital of Canberra and in Joyce’s home state of Queensland, where Chinalco would mine new assets.

Australia’s Foreign Investment Review Board took the deal under review and the Senate launched its own inquiry.

Rio Tinto last week announced that it would scrap its financing deal with Chinalco and instead pursue a deal with Australian rival BHP Billiton PLC (NYSE ADR: BHP).

Rio will combine its western Australian iron ore assets with those of BHP Billiton into a 50-50 joint venture. The JV partners plan to “jointly market” an unspecified amount of iron ore overseas.

BHP will pay Rio $5.8 billion as part of the deal, which the companies say will generate about $10 billion in cost savings.

Rio also will pursue a $15.2 billion rights issue to help pay down its debt.

Deutsche Bank AG (NYSE: DB) estimates that the $21 billion cash injection Rio will get from its BHP deal and its planned rights issue will slash its debt/equity ratio from a high of 63% all the way down to 28%.

Rio Tinto claims its decision to rebuff Chinalco and align with BHP was purely economical, and was designed to better serve investors who didn’t want to see their shares diluted. But that argument has been a hard sell to irate officials in China.

Chinese Outrage

While investors and politicians in Canberra cheered the collapse of the Rio-Chinalco deal, Chinese officials were anything but amused.

"In recent weeks, Chinalco has worked hard to respond constructively and engage with Rio Tinto to make appropriate amendments to the transaction terms announced in February to better reflect the changed market background and feedback from shareholders and regulators," said Aluminum Corps. of China Chairman Xiong Weiping. "As a result, we are very disappointed with this outcome."

Xiong requested a meeting with Prime Minister Rudd shortly after Rio Tinto announced its new deal with BHP Billiton.

Prior to the talks, Rudd stressed that the decision to abandon the deal with Chinalco was entirely Rio's decision – and wasn’t influenced by the the government. He also said that it’s “very important that our friends in China recognize that fact.”

Said a spokesman for Rudd after the meeting with Xiong: "The Prime Minister explained that Australia welcomed foreign investment."
But the assurance that Australia is still open to Chinese investment wasn’t enough to pacify Chinalco, which is worried about the effect a BHP-Rio alliance will have on the price of Australian iron ore.

"After BHP Billiton and Rio Tinto establish the joint venture, large iron mines in Australia will belong to one company and this will lead to a monopoly operation," China Iron and Steel Association (CISA) General Secretary Shan Shanghua told China's influential Caijing Magazine. "China needs to import almost half of the iron ore it consumes, while the volumes from BHP Billiton and Rio Tinto account for more than half of imports."

The World Steel Association also opposes the BHP-Rio Tinto deal, which would leave just two suppliers – the Australian joint venture and Brazil's Vale (ADR NYSE: VALE) – controlling 70% of global iron ore trade, Reuters reported.

“There are still two major Australian producers of iron ore selling into the Asian market,” said Rio Tinto Chief Executive Officer Tom Albanese, who downplayed the BHP deal. “That has not changed.”

However, Rio Tinto Chairman Jan du Plessis said the new joint venture would establish an “an unrivalled iron ore business.”

Some analysts believe disgruntled Chinese steelmakers will simply start buying more ore from Brazil’s Vale SA (NYSE ADR: VALE) – the world’s No. 1 iron-ore producer – in protest. And, at the very least, the Rio-BHP venture could encourage steelmakers to take an even harder line in already-contentious iron-ore price negotiations.

Rio Tinto said last week that it agreed to a price cut of between 33% and 44% with Japan’s Nippon Steel Corp. But Chinese interests have already made it clear that they expect an even larger discount.

“This does not represent the mutually-beneficial relationship between steel producers and iron ore suppliers,” the CISA said in a statement. “Chinese steel companies will not accept or follow the price cut.”

China continues to demand 40%-45% reduction in iron ore costs. And if that fails, the CISA says it is prepared to cut steel production before it relents.

Will there be a showdown between iron ore producers and buyers? If steel producers are not going to be profitable, they will cut back in production. This is a business reality. If this happens, steel price will go up and the fragile recovery will be further set back. Every body will lose including iron ore producers. On the other hand, if iron ore producers do not make a profit, they could not stay in business for long. Is this what comes down to? How ugly can this get?

"Today’s national accounts data shows a fairly large contribution to growth from net exports in the March quarter, and that follows a substantial contribution to growth from net exports in the December quarter. We’ve got two quarters now of strong contribution from net exports."

And I didn't say Australia shrugged off the recession. I said it shrugged off the global downturn to post 0.4% GDP growth in the first quarter.

[…] June, for example, BHP reached a $116 billion deal with Rio Tinto PLC (NYSE ADR: RTP) that will allow the two mining giants to merge their Western Australia iron-ore operations. Also, they are in a friendly $200 million takeover of United Minerals, which has deposits […]

[…] June, for example, BHP reached a $116 billion deal with Rio Tinto PLC (NYSE ADR: RTP) that will allow the two mining giants to merge their Western Australia iron-ore operations. Also, they are in a friendly $200 million takeover of United Minerals, which has deposits […]

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